Influencing Target Company Stock Prices
The target company itself can have an influence on the potential price offered in a number of ways:
By having a strong defense in place to protect the company from an unsolicited takeover bid. Such defenses can include so-called poison pills (including under-funded pension plans), shares owned by insiders or in friendly hands, golden and silver parachutes not just for senior management but for a wider group of employees (often called “tin parachutes”), and a history of successfully fending off hostile bidders. Research has shown that these defenses, especially poison pills, do result in higher premiums for target companies.
Most of these defenses are put in place to make it more difficult (that is, expensive), but not impossible, to be purchased. For example, Mellon Bank put in place tin parachutes for all its employees following an unsuccessful hostile bid by the Bank of New York in 1998; when later, in 2006, a friendly deal was proposed and accepted by Mellon Bank, the senior managers and employees were requested to waive their golden, silver, and tin parachute rights in order to put them on an equal footing with the Bank of New York employees, who had no such employment provisions.
By letting the market know that a high threshold premium value will be required for any unsolicited bid before the board of directors will recommend it to the shareholders. Yahoo! used this technique when it successfully fended off an unwelcome bid from Microsoft in early 2008 that had a 62% premium associated with it (a so-called “bear hug” offer, which designates an offer above the typical premium range of 20–40%).
By encouraging competing bids. By opening up the purchase of the company to an auction, the directors admit that the company is for sale and will likely lose its independence, but that they are actively seeking the highest possible price. After Morrisons, the supermarket chain in the United Kingdom, made a formal offer to purchase Safeway for £2.4 billion in January 2003, an auction for Safeway ensued with competing bids from Asda (controlled by Wal-Mart) and J. Sainsbury. There was a feeding frenzy that included Tesco, retail magnate Sir Philip Green, and venture capitalists Kohlberg Kravis Roberts. The price that Morrisons ultimately paid for Safeway was £3.0 billion.
Bidders can also influence the target company’s share price, naturally wanting to keep the price of the target down. The most common technique is to conduct a “street sweep,” whereby the target company’s shares (or a controlling interest in the target) are purchased in a blitzkrieg that gives the market and the target’s management no time to react before the takeover is effectively complete. This is very difficult to conduct in practice, and is most successful when a small number of shareholders control a large percentage of the target’s shares or where the bidder already has a large ownership in the target. Thus, for example, Malcolm Glazer, who for a long time had been holding 28% of the publicly listed football club Manchester United, purchased a similarly sized holding from Cubic Expression in May 2004, and thus in one purchase came to control the club.
Many bidders, when purchasing their toeholds in potential targets, will publicly announce that they have no interest “at this time” in making a bid for the entire company, maintaining that their holding is a financial interest only “because the shares represent an attractive investment.” This was the position declared by Malcolm Glazer in the Manchester United case from the time he first disclosed a 3% ownership in the club in March 2003 up until the time he bought the shares that gave him control in 2005. In his case, the market expected a bid for the entire company, but his public position nevertheless may have lowered the price he ultimately had to pay for that controlling interest.
In all of these situations, it must be noted that proper legal advice must be taken in order not to fall foul of the many regulations and laws that prohibit market manipulation.
Equity Market Reactions for Bidders
The shareholders of acquiring companies are not as fortunate as those of the targets. On average, their shares decline in value around the time the company announces its intention to take over another company. Thus, in the example above, when Morrisons launched its surprise bid for Safeway (at a 30.3% premium to the prior day’s close), its shares declined 14.3%, and when J. Sainsbury entered with its competing bid, its own share price declined on the day by 3.5%. The shareholders of neither bidder benefited, in distinct contrast to Safeway’s shareholders.
Because of the relative consistency over time of stock market movements in response to deal announcements, the market will assume that future deals will do the same, including that only 30-40% of all deals are successful, that mid- and long-term shareholder wealth declines by 10-35%, and that the share prices for acquirers and targets move within certain ranges (on average) around the announcement day. Merger arbitrageurs—whether in hedge funds or investment banks—take large positions knowing that bidders’ share prices tend to drop immediately after a deal announcement and that targets will see share price appreciation. This then becomes a virtuous (or vicious, for the bidder) cycle, where the movement in the share prices is magnified by this arbitrage activity.
In many cases these movements in share price can lead to extreme changes in share ownership. For example, when the Deutsche Börse (the largest stock exchange at the time in mainland Europe) made a bid for the London Stock Exchange in 2004, the Anglo-American arbitrageurs rapidly became the largest group of shareholders, displacing the long-term German shareholders, whose ownership was reduced to only a third. It was these arbitrageurs who forced the Deutsche Börse CEO to drop the bid in March 2005, leading to a 30% price rise in the Deutsche Börse shares as it became less and less likely that the deal would succeed.
As with the Deutsche Börse CEO who didn’t anticipate this change, most managers seem to be oblivious to facts which appear to be obvious to those outside the company. A DLA Piper survey in 2006 showed that 81% of corporate respondents rated their M&A experience as fairly or highly successful, and over 90% of venture capitalists felt the same, yet we know that 60–70% of all deals fail.